Homeland Investment Act: The Last Time America Had A Corporate Tax Holiday, And What Happened Next

The leadership transition in the White House has given rise to uncertainties concerning several policy issues. With President Donald Trump preferring to blaze a new trail in his bid to "Make America Great Again," many policy overhauls are likely to transpire. Proving that his election promises are not empty ones, Trump recently signed orders to pull out of the Trans Pacific Partnership, or TPP.

He has also signed two executive orders regarding immigration, encompassing his campaign promises to construct a wall on the U.S.-Mexico border, boost patrol forces and increase the number of immigration enforcement officers who are vested with the responsibility of deportations.

Trump had promised to lower the corporate tax rate to 15 percent from the current 35 percent, reasoning that America is suffering because it's burdened with one of the highest corporate tax rates in the world. Additionally, Trump also proposed to create a tax holiday to facilitate repatriation of profits made overseas at a lower tax rate.

What Is A Corporate Tax Holiday?

A corporate tax holiday is a way the government incentivize companies through a reduction in corporate taxes or elimination of taxes. This is done with the intention of attracting foreign investment or increasing business investment.

In the current context, the government is seeking to declare a tax holiday in order to encourage the U.S. companies operating overseas to repatriate the profits these companies make abroad by charging a lower tax rate. A CNBC report quoting Capital Economics, said U.S. companies have parked $2.5 trillion abroad, up 20 percent over the past two years.

The tax holiday being contemplated has precedence. Wells Fargo in a note looked at how corporations reacted to the Homeland Investment Act passed in 2004 and how the dollar reacted to the responses of companies to the regulation. Based on a letter from the U.S. Joint Committee on Taxation, the firm said the amount of profits held overseas was around $2.6 trillion in 2015, while its own estimate based on historical growth data is around $2.7 trillion for 2016.

The Homeland Investment Act Of 2004

The Homeland Investment Act provided for a one-time tax holiday on the repatriation of foreign earnings by the U.S. multinational enterprises, or MNEs. This act was a part of the American Jobs Creation Act, as it was expected to help in creating more than 500,000 jobs over two years through the avenue of increased investment in the United States.

Effects Of The Tax Holiday

Estimates by the Bureau of Economic Analysis show that companies repatriated about $300 billion in 2005 after the act was passed, up from an annual average of about $60 billion over the previous five years.

Meanwhile, Wells Fargo estimates that flows spiked in 2005, rising to nearly $150 billion in the fourth quarter of 2005 from an average run rate of about $20 billion per quarter prior to the tax holiday.

Dollar Moves On The Tax Holiday

Wells Fargo global economist Jay Bryson and currency analyst Erik Nelson looked at the behavior of the dollar amid the tax holiday. The dollar strengthened on a trade-weighted basis throughout 2005 after multiple years of downside. Incidentally, the dollar weakened in the subsequent years. The analysts also looked at the other potential causes of the dollar rally in 2005, including the Fed tightening cycle underway and the rising yield of two-year U.S. government bonds relative to their overseas counterparts.

The analysts also stated that if the profits held overseas were in the form of dollars, it might not have any impact on the forex, as the scenario would result in only dollar distribution. However, if the profits were in foreign currencies, the increase in demand for the dollar to facilitate the repatriation of profits would firm up the dollar. Concluding, the analysts said repatriation flows in 2005 would have had at least a marginal impact on the dollar.

Trump's Tax Holiday—An Estimate

Taking the $300 billion in profits or 30 percent repatriated in 2005 out of the estimated $1 trillion held overseas and applying to the current scenario, Wells Fargo believes roughly $900 billion of the $2.7 trillion will be repatriated. This represents 4.9 percent of the 2016 GDP, 189 percent of the current account deficit and 65 percent of the daily spot dollar turnover. This corresponds to 2.3 percent of GDP, 40 percent of current account deficit and 57 percent of daily spot dollar turnover in 2005.

Likely Dollar Impact

Since the $900 billion estimate of Wells Fargo represents a large portion of the U.S. current account deficit relative to 2005, repatriation in the current period will provide more support to the dollar than the 2005 repatriation. Since the proportion of the spot dollar turnover is similar both the periods, this metric is expected to provide similar support. Thus, Wells Fargo sees the new repatriation period having either a similar or perhaps greater positive impact on the dollar than in 2005.

At last check, the SPDR Dow Jones Industrial Average ETF DIA was up 0.13 percent at $200.68.

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Image Credit: By Executive Office of the President of the United States [Public domain], via Wikimedia Commons